A Different Way to Profit From Options (Part 2)

Managing Editor’s Note: Today, we’re once again turning this over to colleague Larry Benedict – a market wizard and legendary hedge fund manager.

Today, he’ll share the second part to the unique strategy he introduced you to yesterday… one that sets himself apart as a successful trader.

Here’s Larry with the details…

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Yesterday, we looked at a trade from earlier this month using a strategy called a “bear call spread.”

A bear call spread is a great way to profit when you’re bearish on a stock.

(If you missed it, you can read about that strategy here.)

So today, I want to turn our attention to a similar strategy we use when we’re bullish instead.

It’s called a “bull put spread.”

And like our bear call spread, I look for where the market is unlikely to trade.

We’ve used both strategies with great success at The S&P Trader, with a long-term win rate of around 80%.

So what is a bull put spread all about?

Generating Income

A bull put spread involves two parts (“legs”).

We sell a put option at a level below where we think the SPX is going to close.

We simultaneously buy a put option at an even lower level. That protects us if the market falls below our sold put position. It caps our maximum loss if the trade doesn’t go our way (more on that below).

This strategy enabled S&P Trader members to generate $4.60 in premium (or $460) in a single day for each contract they traded.

So let’s run through how our trade worked…

The S&P 500 (SPX) fell after the market open on May 2 before recovering strongly. It closed out the day near its daily highs:

S&P 500 Index (SPX)

Source: eSignal

The next day, that uptrend continued. SPX gapped higher and seemed poised to stay strong. So I decided it was time for another trade.

I recommended a bull put spread that would expire that same day (May 3).

We sold a put option with a strike price of 5100 (upper orange line).

At the same time, we bought a put option with a strike price of 5080 (lower orange line).

Our sold option earned us a credit, while our bought option cost us a smaller amount.

Together, they generated $4.60 in premium, which equates to $460 per contract.

As long as SPX closed above 5100, we would get to keep all of the premium we received.

The good news is that’s exactly what happened.

SPX came within a few points of touching 5100. But it closed out the day at 5128.

So the full premium remained ours to keep.

Balancing Risk and Reward

Our win was a close thing, as SPX traded within a few points of our sold put.

If SPX had fallen to 5100 or lower, we would have likely taken a hit.

But the most we could have lost with this trade was the difference between the two strikes (5100 and 5080) minus the premium we received.

In this case, our max loss would have been $20 – $4.60, which equals $15.40 (or $1,540 per contract).

That’s worth noting because there’s a trade-off you always need to consider.

The closer the strike price of your sold put option is to the current SPX price level, the more premium you’ll receive.

But it comes with a higher chance of a loss on the trade. Remember, we place our trade in a range we think SPX is unlikely to trade. That’s how we profit.

If you choose a strike price far away from where SPX is trading, there’s less chance of losing out. But you receive less premium as a result.

So you have to find the right balance when you place one of these trades.

Decades of using these strategies have taught me where that balance lies. And that’s what I share with my subscribers.

Given our high win rate, we’ve managed to generate some impressive returns.

Last year, for example, we earned over $11,000 using bull put and bear call spreads (for just one contract sold per trade – if you traded multiple contracts, you made even more).

And as always, my goal is to do even better this year.

If enjoyed this trading breakdown, I’d love to hear about it. You can share your thoughts and ideas at [email protected].

Regards,

Larry Benedict
Editor, Trading With Larry Benedict